Buying Apartment Buildings

By: Pierre McLean


Apartment buildings usually have a myriad of commercial real estate lenders amenable to financing this property offering various loan products. It arguably could be considered the "bread and butter" of the commercial real estate industry in which most individuals who aspire to enter the commercial real estate arena, attack. It has elements of single family and small multifamily tenancy scaled to a larger degree with other elements differentiated from residential real estate. Regardless, as real estate, apartment buildings have the elements inherent in realty which quantifies its desirability as an investment vehicle. What it shares with the other real estate property types and real estate as a whole is:-

Some of the Pros and Cons of Real Estate:-

Pros

a) Potential high yields - real estate investments inherently have the potential for high yields depending on the utilization of the property to maximize its potential, the deal structure implemented, strategies used to add value to project, exit strategies, etc. These can effectively extract a rate of return which compensates for the risk applicable to this form of investment.

b) Leverage - the acquisition of real estate and its subsequent refinancing or disposition benefits from the assets class capacity to be leveraged. This increases the rate of return which can be captured from respective projects, decreases the amount of the investor's capital tied up in a deal and the extraction of capital from one property through refinancing or resale to facilitate the pyramiding of equity into larger properties, diversification into other real estate categories, other investments, etc.

c) Income Tax Flexibility - real estate continues to offer tax write-offs which can reduce the taxable income of investors and investment entities. These are inclusive of the deduction of applicable operational expenses, depreciation, tax credits for projects meeting certain criteria, tax reductions, etc. This can create a scenario where there is paper negative cash flow while the project is operating profitably.

d) High Degree of Personal Control - the ownership of real estate can be active or passive. Active ownership of real estate affords direct operation or management of the investment and being in a prime position to maintain or add value to the project. This degree of control is reassuring for some people and the tangible aspect of real estate fulfills a security component desired by others.

Cons

Illiquidity - the real estate market is imperfect which does not create a readily viable mechanism to sell real estate in comparison to other investments, e.g. stocks, bonds, etc. This generally delegates it to a longer term investment without the ability to dispose of it in response to fluctuations in the market.

a) Large Capital Requirements - the capital required to acquire and maintain real estate is substantial. This is relative, but added to the illiquidity of the investment creates a level of associative risk that deter some individuals from entering the real estate investment market. The capital allocated for buying real estate usually represent a large capital commitment for many buyers coupled with the uncertainty of the demise of the project.

b) Constant Management - in order to maintain value, add value, maintain habitability, satisfy tenants, etc it is necessary to constantly manage investment real estate. This helps to preserve and protect the investment and it can be a requirement of lending institutions that have loaned funds to the owners, compliance with building codes, OSHA requirements, etc.

c) Risk - investing in real estate have substantial risks which can be exasperated with the duration of ownership, specific real estate project, micro and macroeconomic variables, etc. Different investors have various risk quotients which determine their comfort level with real estate projects in various monetary, economic, regulatory, competitive, etc environments.

Various investors will be affected differently by these variables in terms of the profitability they are able to extract from specific properties, the overall success of their real estate portfolio, their capital risk tolerance, etc. However, being aware of some of the potential upside and downside inherent in investing in real estate enhances your capacity to capture the upside and mitigate the downside maximizing the return on your investment capital.

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Pierre A. McLean is the Managing Member of Commercial Mortgage Funding, LLC located in Forked River, New Jersey, a commercial mortgage brokerage firm. He can be contacted at Commercial Mortgage Funding, LLC, 610 Lacey Road, P O Box 202, Forked River, NJ 08731, Tel: (609)971-7171, Fax: (609)971-7144, email: [email protected] website:Commercial Mortgage Funding, LLC

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